Michael Johnson, who I’ve a lot of time for, has asked me two questions.
Why is it not possible to provide the attributes of a CDC scheme through a With Profits fund, set in the context of an occupational scheme with allied governance and regulatory protections?
What fundamentals does a CDC scheme provide that such a WP fund would not?
Nothing wrong with-profits provided….
I will declare neutrality on “with-profits”. Despite being a child of Mark Weinberg – being taught from the cradle that with-profits was an insurance company con, I worked at a company (Eagle Star) that moved from the gloom (Roy Brimblecombe) to a golden age (Harold Snow) when in the late eighties it ran a unitised with-profits fund that even I could explain.
Infact I spent two days in Goole, talking to workers at the Cookson Vesuvius plants about the way that with-profits bonuses were paid and why there were losers as well as winners. I won’t do the presentation here, but I know that people “get” smoothing, when it is explained by someone who takes the trouble. Eagle Star were good at explaining things and we were accountable to Bacon and Woodrow for how we said it. I mention this because at the time, Kevin Wesbroom was the boss at Bacon and Woodrow, Cookson were his client and I am still learning from him today.
I am not saying that Eagle Star had a monopoly, far from it, at the time it was the Equitable Life who ruled the roost, though that changed very quickly.
The Prudential also had a large stake in the pensions with-profits market though – like Equitable’ s with-profits, nobody could quite understand how it worked.
The Prudential have now created a with-profits fund that advisers can explain. Of all the products on sale in Port Talbot, the Prudential’s with profits fund was the only one that a steelworker could explain back to me with a degree of confidence. It may not be an optimal solution, but a with-profits approach is intuitively right for people who want a smoothed return from which to draw an income in retirement.
With profits is a useful starting point in thinking of CDC
But with-profits has limitations. The job of any “appointed actuary” (now I believe an actuarial functionary) is to “document the liability reserve of an insurer”.
CDC does not provide “insurance” – there are no liabilities in the sense that an insurance company actuarial functionary would understand them. There need be no formal reserving policy to back up the promises of a CDC plan.
This conversation between two (ahem!) pension consultants shows highlights how radical CDC actually is.
You decide by looking at your best estimates of the future finances of the scheme and asking what level of increases can we sustainably afford . It’s not a case that trustees just decide whether it feels good or bad.
— Kevin Wesbroom (@kevinwesbroom) May 4, 2018
Later in the conversation, Wesbroom explains that the link between the employer and the outcomes of CDC simply doesn’t exist
It’s not the sponsor you need to keep honest. Once they have paid their contributions they have no vested interests – it’s not like DB. The trustees are the ones who have the difficult act of being fair to all generations of members. 50/50 representation here.
— Kevin Wesbroom (@kevinwesbroom) May 8, 2018
Wesbroom concludes his conversation by making a point that is crucial to the questions Michael asks
Nice try John – but bonds is best doesn’t work here. The fundamental nature of CDC pensions – no guarantees! – means that some different (smarter?) investment thinking is needed to back CDC pensions. Copying DB models (which is what Dutch CDC schemes do) won’t work.
— Kevin Wesbroom (@kevinwesbroom) May 8, 2018
It takes considerable wit, experience and integrity to explain in such short space the essence of CDC – I take my hat off to Kevin Wesbroom.
But to answer Michael’s questions directly….
With-profits is governed by guarantees which need to be reserved for. This process requires insurers either to put aside liquid reserves (which tie up capital) or shift assets from growth to matching (as John Ralfe would do).
CDC is not governed by guarantees and does not need to reserve in the same way, it can distribute 100% of assets over time and the timeframes are unlimited. It therefore does not have to invest in bonds – “bonds are best doesn’t work here”.
Because CDC does not have recourse to an employer when times are bad, it can only reduce pay-outs. If an aggressive distribution policy is established, this may mean cutting pensions. If the CDC plan is less ambitious, then it’s unlikely that pensions will be reduced (in nominal terms) , it will be the level of increases that will be impacted.
The inclusion of any form of “guarantee” within an occupational scheme, would create not just a reserving issue, but a very real fear in employer’s mind that the insurer of last resort would be them. In his response to John Kiff, Kevin makes this point really well. In CDC, employer’s sponsor contributions – no more.
Finally, behind Kevin’s response to Mike Harrison is the central dictum of a CDC distribution strategy – “transparency”. When I explained Eagle Star’s with-profits policy, I was able to articulate what the appointed actuary told me, I could translate his arcane words into simple language that the workers in Goole could understand.
The rules of the Eagle Star unitised with-profits fund were very simple and its operation understandable. It became much loved (not least by Kevin Wesbroom) not for being “with-profits” but for it doing what it said on the packet. The accountability of a with-profits approach was seldom tested. When Andrew Warwick-Thompson pointed out that the Equitable Life’s distribution strategy rendered its with-profits fund technically insolvent, he was sued by the Equitable. Kevin Wesbroom will remember this – Andrew was a colleague.
But the central point is clear, for the most part, with-profits was not properly explained to those participating in it and not properly monitored by those who should have monitored it. CDC has the opportunity to break free from the insurance company black-box and do what Eagle Star did (albeit very briefly).
Fundamentally, CDC differs from with-profits because with-profits guarantees things and CDC doesn’t. With-profits is the product of an insurance company, CDC provides non-insured pensions based on collective pooling of longevity risk and the collective investment of contributions.
The reason why the insurance companies are so against CDC is because they have virtually no role to play in insuring people live too long , nor guarantees to provide within the scheme.
If we had been talking of this 20 years ago, I am sure that CDC would be hailed as the dawn of the “new mutual” by DEMOS. It has taken us 20 years to get over the demise of with-profits (at least the Equitable Life version) and to move on.
CDC moves beyond the practices of with-profits funds in the latter part of the 20th century and reconnects with the earlier principles of mutual societies which were based on mutual protection. Of course, we have tools in the twenty first century that were not around in the nineteenth, when mutuality first prospered. But CDC links back to that earlier “disintermediated” time, when what people got in retirement was linked to the collective endeavour and integrity of a mutual society.
Why CDC is not with-profits
This philosophical point is fundamental, CDC need not be a fund – as we know funds today- it simply needs to a means of paying people a wage for life – which people trust – and are right to trust.
For these reasons, we should not think of CDC as the equivalent of a with-profits fund. It is fundamentally simpler, more direct and more ambitious.